Read the previous two posts first. Here’s Bernanke’s policy recommendation, in its entirety:
CHAIRMAN BERNANKE. Thank you. Well, again, thank you, thank you all. I do think we need to move today. Once we take into account the drag from financial conditions, arguably the current rate is neutral or even somewhat restrictive. For example, the Taylor rules in the Bluebook have the neutral rate between 4 and 41⁄4 percent. Moreover, there has been quite a market change. Whether you look at markets or look at simulations, the FRB/US equilibrium real funds rate, for example, is down 70 basis points since the last meeting, which of course is just a summary of the revision of the forecast. On the other hand, you get similar numbers when you look at actual market indicators. So I think there is a sense in which our policies become de facto more restrictive and need to be addressed. On top of that, there is some case for insurance, although the discussion around the table illustrates that that is a complex idea when you, in fact, have a dual mandate and there are risks in both directions.
If the choice were between 0 and 50 basis points, I would be very tempted to do 50 basis points. I think it would move us more toward accommodation, and it would be very pleasant to get the same kind of market response we got after September in terms of improved functioning and credit extension. That said, I think there are some risks to going with 50 basis points. I acknowledge what others have said, which is that it is not just about the rate but also about what the message is. In particular the markets already expect us to ease quite a bit more. We are not pushing strongly back against it with 25 basis points. If we do 50, we may be saying to the market that we are willing to do even more than you currently expect. I think that poses some risks to inflation expectations and poses some risks to the dollar, which is a little fragile right now. You can imagine it even having reverse effects with respect to the economy—for example, if it caused oil prices to jump or if it caused nominal interest rates to rise, thereby raising nominal mortgage rates. The other concern I have is that, for better or worse, given our communications and market expectations, at this point a 50 basis point cut would be viewed as something of a lurch and might signal, as others have suggested, more concern or private information about the economy that we in fact don’t necessarily have. You can tell that I am quite conflicted about it, and I think there is a good chance that we may have to move further at subsequent meetings. In that respect, it is very important that both in our statement and in our intermeeting communications that we signal our flexibility, our nimbleness: We are not locked in, we are responsive to conditions on both sides of the mandate, and we are alert to new developments.
With all of that in mind—and although I don’t think the TAF is really a significant substitute for monetary policy, on the margin I think it is helpful—I recommend 25 basis points and alternative B. I did not hear much support for a downside risks sentence, and I agree that adding it would probably not very substantially affect the signal that we are sending today. So that is my proposal. Any comments? If not, could you please call the roll?
After the extravagant praise I gave Mishkin, you might expect me to trash Bernanke’s policy recommendation. In fact, it doesn’t do much for me either way. If you look at the bolded sections it’s clear that Bernanke understands Mishkin’s comments, and indeed I’d guess if you asked him in private he would have told you that Mishkin made the bast case of anyone in the room. But in the end Bernanke opted for 25 basis points. Why?
1. Perhaps he had more concern about inflation than Mishkin did.
2. Maybe he knew he didn’t have the votes, and wanted to be in the majority. Perhaps he had not had time to round up enough support, as conditions deteriorated quite rapidly right before the meeting. He didn’t want to be in the minority; a very awkward position for the Chairman.
3. And along with option 2, he probably thought there was still time to do further cuts, if it became obvious that the Fed had erred.
Was it too late after this fateful vote? I don’t think so, RGDP rose at late as the second quarter of 2008. Aggressive easing in 2008 certainly could have prevented a severe recession. On the other hand I think there was some permanent damage done. Mishkin was right that it was important that market understood that the Fed would do whatever it takes to prevent a big drop in NGDP. The December 11, 2007 decision made markets a bit less confident on that point, which would come back to haunt the Fed in late 2008.
Come back here next year for my analysis of the 2008 transcripts—that’s when things will really get interesting.